Iran's New Petroleum Contract: a Break with the Past

Iran has huge oil and gas reserves and is among the top countries with oil and gas reserves, but years of sanctions and war since the 1979 revolution have prevented the country from receiving the required technology and investment. It is hoping that the new upstream contract will end the isolation.

In an interview with NGE, Iranian-born analyst Sara Vakhshouri, who runs Washington-based energy consultancy SVB and is also a senior energy fellow with the Global Energy Center at the Atlantic Council said that all the ups and downs Iran has faced make it an untapped market, especially in the gas field: “Iran has huge gas reserves and the production costs of oil and gas are very low, the complexity of the rocks are very simple, the rate of return and production is high, especially in the gas fields. It's really an untapped market.”

Still, she says that Iran's huge consumption of gas has prevented it from entering the global market.

Could you talk a bit about the trade off involved in Iran marketing its gas globally for the state to earn revenues versus using it for its own domestic needs? How does this figure into the thinking behind how the country pursues this?

Gas accounts for 65% of Iran's domestic energy demand, most of which is used for electricity production and household consumption. It also uses gas for injection into its mature oilfields to maintain its oil production.

It's a unique country in that most households have piped natural gas in their home. Many years ago the government increased the domestic pipeline system, so everyone receives natural gas from a central network which means that they don't require any liquid petroleum gas.

Iran also initiated a huge petrochemical industry during oil minister Bijan Namdar Zangeneh's first term, during when Mohammad Khatami was president over 10 years ago. Within eight years he had increased Iran's petrochemical production and export significantly, and there are still some petrochemical factories awaiting completion in the next couple of years. The feedstock for all of these facilities is natural gas.

Iran has a policy of turning natural gas into electricity and export that electricity to neighbouring countries as well as exporting it as natural gas.

If we consider the psychology of Iran's leaders we can understand why they placing a lot of emphasis on consuming natural gas domestically and converting that product into other ones and adding value to their natural gas, enabling the export of the more value-added product.

Iran was dealing with so many different sanctions, particularly in 2012 when oil exports were hit. So Iran's leader, Ayatollah Khamenei, announced the idea of “Economy of Resistance” and one of the main components of this doctrine was to convert Iran's resources into more value-added products and, instead of exporting raw resources, exporting the products that have been produced from these resources. For example, if Iran exports electricity to its neighbouring countries instead of natural gas, it would much it harder for the international community to place a ban (read sanctions) on the export of electricity, because it goes directly to people's houses.

However, export of natural gas is very important for Iran because this involves long-term deals unlike crude oil exports, which typically have only 1-year contracts or 5-year contracts. 

It's important for Iran to create such long term economic ties and alliances with the countries that are receiving Iran's natural gas.

Regarding the route of Iran’s gas export, the country has land access to many countries and is able to export its gas via pipelines, and it has also access to water so it could use LNG. However, LNG hasn't really been developed in Iran because of US sanctions. Developing a liquefaction facility for Iran has always been very challenging, so there's no near-term capacity to be able to export LNG, unless it pursues alternatives facilities like floating LNG for such exports.

Domestically, pipeline routes are the best way and an immediate way of exporting natural gas. LNG could come after that and FLNG would be one of the first options for export.

Iran is going to build further natural gas capacity to export in the medium term. They're developing further phases of South Pars, the giant gas field in the south of Iran which is a shared field with Qatar.

Iran is hoping that by 2018, (although we estimate by 2020), that it will have enough natural gas to expand its export. How big that could be is tough to estimate as Iran does not have a clear strategy of how much they want to export in the form of natural gas itself. As I mentioned earlier, they have many plants in which they can utilise their additional natural gas capacity: as feed stock for petrochemical factories, part converted as electricity, part of it going to Iraq – some agreements regarding that have already been signed. So how much extra gas Iran is going to have to export to Europe, or to Oman to use its liquefaction capabilities and re-exporting the gas in the form of LNG, are outstanding questions.

In light of the “buyback scheme” of the past, could you speak about the elements of the Iranian Petroleum Contract (IPC)?

Before the 1979 revolution, Iran had issued concessions, through which international oil companies would invest in its energy industry.

Following the 1979 revolution, foreign companies' presence was really reduced significantly in Iran. But by the end of 1999, early 2000 Iran introduced buyback contracts, which were initially for involving international companies in IOR/EOR projects, basically to help in enhancing recovery in mature fields and maintain their production. Later on, Iran expanded the buyback contracts for the exploration projects and development projects both for the green fields and brown fields.

After the Iraqi market was open and there were massive opportunities – Kurdistan began offering production-sharing contracts – and with the simultaneous opening of the Iraqi market, sanctions were tightening on Iran – many international companies left Iran, not only because of sanctions but because they were not interested in working under the buyback scheme.

The major differences between the buyback contracts and the IPC is that for the first time since the 1979 revolution Iran is going to allow international companies to be involved in the production process, so not just in exploration and development projects but also in the production process.

The other major difference is the timeline of the IPC contract. In buybacks the company would sign a contract of 5-7 years, while the IPC contract is 20-25 years: the companies are involved in a field for a longer time. Leadership hopes that this will not only be politically good for Iran, as it engages the company for a longer time and creates longer stakeholders in Iran, but economically it is also good because the companies are involved in the project for longer term.

With IPC, international oil companies are involved in the production process and can help Iran with the marketing and selling of produced hydrocarbons of the field.

The other difference between buyback and IPC is that the cost and profit ceilings are flexible.

Another important difference is that in the IPC the exploration, development and production process of a field are integrated; before, one company would do the exploration, and then had to enter the bidding round to be able to take over the development of the filed.

In that context, how important is the Iran Petroleum Contract (IPC)?

It is very important because the IPC includes a lot of incentives for international investors to invest in Iran. However companies are interested in investment in Iran not only because of the IPC – but there are other additional factors.

Personally, I think the low oil prices are a lucky charm for Iran, because the production costs in Iran are really low and you can't find any other place in the world that has such low production costs. Also, companies that are coming to invest in Iran would have access to both oil and gas reserves.

Another advantage is that there are huge amount of opportunities in the field of development. Nowadays companies are more interested in development projects more than exploration projects.

Furthermore, Iran is a gold mine for service companies.

However there are still many risks involved with investment in the Iranian energy industry and we shouldn't forget that US companies and banks are still not going to be involved in this game because of the remaining sanctions.

Considering the geopolitical risks in the Middle East, how attractive does Iran stack up in comparison with other places?

This IPC regime is not a production sharing contract (PSC), which is still the most attractive contract regime. Companies are interested in booking more reserves but IPC doesn’t allow the international oil companies to book reserves.

Compared with other neighbouring countries, of course we still have Iraqi Kurdistan that offers PSCs and the Iraqi government that is doing some reforms regarding upstream contracts. Iraqi production costs are similar. Mexico is also engaged in massive reforms.

What we have observed is that due to the remaining investment risks in Iran, countries are more interested in engaging in Iran rather than individual companies. For instance some of the European companies like Total or Eni are planning to invest in Iran's energy industry as part of their countries' broader economic engagement with Iran.

How do you see investment in Iran's oil and gas sector contributing to better relations with the West?

It will better relations with Europe. They're already getting closer than they were. Traditionally, Iran has always been interested in having relations with the West rather than with China or Russia. Iranians have some bitter experiences from Chinese involvement in their energy industry. In 2014, the Iranian oil minister annulled some the contracts between NIOC and Chinese companies and withdrew Chinese companies from some of the fields.

Of course, there's always this tendency to have a closer relationship with the West, but I see this primarily with Europe. The sanctions and restrictions on US persons and companies prevent them from doing business with Iran. There is a loophole, which allows the foreign subsidiaries of the US firms to do business in Iran. But in terms of upstream oil and gas investment, I don’t think the IPC is attractive enough for the US major oil companies to take the risk of investing in Iran’s energy industry.

Drew Leifheit